With iPod, HP decides it's better to switch than fight

CUPERTINO, Calif. — Last summer, Hewlett-Packard Co. found itself in an awkward position for a premier computer company: It hadn't fielded a single candidate in the fast-growing market of digital music players.

HP had gone through numerous music player designs and had built several prototypes to show to focus groups. But people kept saying they preferred the celebrated iPod from Apple Computer Inc.

Tom Anderson, HP's vice president of marketing for consumer PCs, couldn't say he was surprised.

The self-proclaimed gadget freak had snapped up an iPod soon after Apple introduced the sleek white devices in October 2001, loading it with classical music and tunes from the Beatles, Rolling Stones and Bob Dylan. He knew the iPod was the gold standard.

So HP switched gears. It dropped an industry bombshell at the International Consumer Electronics Show in Las Vegas last month when it announced it would sell the iPod under the HP brand name.

It seemed a surprise that HP--whose corporate slogan is "HP Invent"--would be willing to market a well-known product created by another company. Or that Apple, renowned for its independence, would agree to supply a Silicon Valley rival.

But the alliance points the way for HP Chief Executive Carly Fiorina's new strategy of "focused innovation," which depends on borrowing technology developed by strategic partners in order to save money and bring products to market more quickly.

The appeal to Palo Alto-based HP is easy to see. Starting in June, the company gets to add the industry's most popular digital music player--call it the "hPod"--to its repertoire. It will package the most popular source for online music sales, Apple's iTunes Music Store, on the roughly 16 million consumer-oriented personal computers it ships each year. The moves will bypass several years and hundreds of millions of dollars of development costs.

For Apple, a niche player in PCs with little more than 3 percent of the global market, the partnership opens a promising new sales channel for a device that at this point claims 62 percent of the worldwide market for hard-drive-based music players, according to market researcher IDC. Apple says its iTunes Music Store has sold more than 30 million songs, giving it a 70 percent share of the legitimate music-downloading market.

Apple sold 1.45 million iPods last year, according to IDC, and the arrival of "hPods" will instantly triple or quadruple sales of the device, technology analyst Rob Enderle predicts.

"This deal explodes their potential," he said.

Apple executives declined to discuss the alliance or the thinking that led to it.

In his office one freeway exit away from Apple's headquarters in Cupertino, Calif., HP's Anderson had spent a couple of years with a team of engineers, product designers and marketers trying to create a device that could compete with the iPod.

He asked: Why go with an inferior product and an inferior music store?

The offer was a bolt out of the blue.

"We didn't think the iPod was an option," said Anderson.

In December, HP began negotiating with Apple in earnest. Anderson wanted to nail down a deal in time to make a blockbuster announcement on Jan. 8, the first day of the Consumer Electronics Show.

Fiorina and Jobs became involved in the talks from time to time, but most of the bargaining was done by Anderson and Tim Cook, Apple's vice president for worldwide operations.

The most intense negotiations concerned myriad issues relating to digital rights, which were handled by lawyers, Anderson said.

Apple already had worked out digital rights management and royalty agreements with the five major record companies, and HP hoped to eliminate the need for having to repeat those tortuous consultations with the record industry.

Just days before the start of the electronics show, Anderson spent several hours at Apple's headquarters hashing out details with Cook's team over take-out sandwiches.

Fiorina and Jobs signed off on the deal.

"Apple's goal is to get iPods and iTunes into the hands of every music lover around the world, and partnering with HP ... is going to help us do that," Jobs said. Fiorina held up a slate-blue version of an iPod as she touted the deal in her keynote speech at the show.

The iPod deal came as a surprise to John Jones, a San Francisco-based hardware analyst with investment bank SoundView Technologies Group. But HP's strategy of using someone else's technology was familiar.

"HP's got a $10 billion laser printer business, and they don't make the printer--Canon does," Jones said. He also noted that HP has a popular digital camera made by a supplier in Asia and soon would sell flat plasma and LCD television sets made by someone else, too.

Although engineering prowess is an important source of both profits and corporate pride, HP saved time and money by striking a deal with Apple, Jones said.

Extending the iPod's reach

For Apple, HP is an ideal partner to extend the iPod's reach beyond its signature Macintosh computers to the world of PCs running Microsoft Corp.'s Windows operating system, said Danielle Levitas, program director for consumer electronics with researcher IDC.

Steve Wozniak, who co-founded Apple with Jobs in 1976 and knows him well, said there was probably one mental hurdle Jobs had to clear to initiate the partnership with HP--the fear of alienating the Apple faithful, who mistrust companies allied with Microsoft.

"Sometimes things are going on in the Windows world that take the world a step backward for the sake of expedient profits," Wozniak said. "But bringing the expediency of iPods to the Windows world benefits both PC users and Apple."